India’s banks can absorb losses. The harder test is keeping credit open.

India enters 2026 with the strongest bank asset quality in years. The Reserve Bank’s December Financial Stability Report puts gross non-performing assets at 2.2% of scheduled commercial bank advances in September and net bad loans at 0.5%. Its stress tests also leave the major banks above minimum capital requirements in the scenarios examined. That is good news for the economy’s capacity to absorb losses. The harder question is how much credit would still reach households and firms if banks conserved capital and wholesale lenders withdrew at the same time. The distinction matters because an economy can experience a credit squeeze with every large bank still open. RBI December Financial Stability Report release · RBI Financial Stability Report, financial institutions chapter

Start with the right denominator

The report’s 2.2% headline covers scheduled commercial banks in aggregate. Its main macro stress exercise uses 46 banks whose starting gross bad-loan ratio is 2.1% and whose aggregate capital-to-risk-weighted-assets ratio is 17.1%. In the baseline that capital ratio reaches 16.8% by March 2027. It falls to 14.5% and 14.1% under the two hypothetical adverse paths. The baseline bad-loan ratio is projected to fall to 1.9%. The adverse capital numbers are conditional results from a model. The sample matters, and the 1.9% is an estimate for the future rather than a measure of current loan quality. RBI Financial Stability Report, financial institutions chapter · The Indian Express’s coverage of the stress tests

At the individual-bank level, the RBI finds no breach of the 9% minimum total capital ratio in either adverse macro scenario. Four banks could use part of their capital conservation buffer in the harsher scenario absent fresh capital. That is what a buffer is for. Using it can still make management and investors more cautious, particularly when losses are rising and an equity issue would be expensive. For an industrial borrower seeking a higher working-capital limit, the distinction between breaching the minimum and operating with a thinner buffer matters less than whether the bank will actually renew the line. RBI Financial Stability Report, financial institutions chapter

A separate exercise is more revealing about the weaker tail. The RBI applies a single credit shock that takes the sample’s bad-loan ratio from 2.1% to 8.1%. The aggregate capital ratio remains above the minimum, but six banks representing 15% of scheduled commercial banks’ assets would breach it. This result belongs to the single-factor sensitivity test. It is separate from the macro scenarios that leave all 46 above the minimum. A useful reading of both is that aggregate resilience is real and that the distribution of losses can still determine which local credit markets come under strain. Customers of a stressed bank may need time to establish a relationship with another lender. RBI Financial Stability Report, financial institutions chapter

An illustration separates the two ways the ratio can move. A bank with ₹10,000 crore of risk-weighted assets and ₹1,710 crore of regulatory capital starts at 17.1%. If provisions and losses reduce capital by ₹300 crore, the ratio falls to 14.1% at unchanged risk-weighted assets. If credit deterioration also raises risk-weighted assets to ₹11,000 crore, it falls to about 12.8%. Conversely, the bank can support its ratio by making fewer new loans or shifting to assets with lower risk weights. These amounts are illustrative, and the RBI’s actual scenario is calculated using bank-level models. The arithmetic explains why a stable ratio can coexist with a reduction in the credit available to a risky but viable borrower.

Where a solvent banking system can still transmit distress

Banks and non-bank lenders serve different borrowers and rely on different funding mixes. A non-bank lender that funds longer loans by rolling short-dated borrowing is exposed to the risk that markets decline to renew it. The lender can then protect cash by slowing originations, including to people who are still repaying on time. A bank that has lent to that company may remain well capitalised while deciding it wants less exposure to the entire segment. The household or small firm that cannot readily substitute a bank loan sees the tightness first. The RBI reports that microfinance and self-help-group lending within the NBFC retail segment contracted over the last two half-years. That makes disaggregated lending indicators worth watching even while the broad NBFC balance sheet looks sound. RBI Financial Stability Report, financial institutions chapter

The RBI’s interconnectedness exercise offers a measure of the exposure. It estimates that failure of the private non-bank finance company with the greatest capacity to transmit losses would absorb 3.0% of banking-system Tier 1 capital in its solvency simulation. The analogous result for the housing finance company with the largest impact is 3.6%. Neither standalone exercise takes a bank below the regulatory capital minimum. A joint shock can still behave differently. Several lenders might face the same funding market and sell similar assets into a thin market. Creditworthy borrowers can lose multiple sources of funding at once. A solvency exercise and a liquidity exercise are therefore complementary, and the same institution can look healthy in one and exposed in the other. RBI Financial Stability Report, financial institutions chapter

There is also a measurement issue in the reported acceleration of non-bank credit. The upper and middle layers together recorded year-on-year credit growth of 21.3% in September, but the RBI says reclassification of two housing finance companies into the upper layer materially affected the comparison. On a common set of upper-layer institutions, credit growth showed some deceleration. A supervisor assessing whether lenders are chasing volume would get a more informative answer by holding the reporting population fixed and inspecting loans by origination quarter and product. Otherwise a change in the reporting boundary can look like a change in how much credit reached the economy. RBI Financial Stability Report, financial institutions chapter

Capital should give lenders room to make distinctions

The strongest case against a tougher supervisory response is that India spent years resolving large bank exposures and rebuilding capacity. Banks now have better aggregate capital and lower bad loans. Excessively defensive lending can deny working capital to firms with sound orders or push households into higher-cost credit. That is a good reason to avoid a blanket restriction. The useful response is to test concentrations and funding dependencies, then ask institutions with concentrated risk to show how they would fund commitments and absorb losses. A large lender with stable deposits, a diverse book and credible loss reserves can keep lending through conditions that warrant caution at a lender reliant on one short-term market. RBI December Financial Stability Report release · RBI Financial Stability Report, financial institutions chapter

Averages also deserve scrutiny when banks are growing rapidly. The bad-loan ratio can decline because existing loans recover or are written off, or because performing balances grow faster than new defaults. The RBI’s half-yearly slippage ratio was stable at 0.7%, with a marginal increase for private banks. Tracking fresh delinquencies and recoveries alongside write-offs and loan growth would show whether the lower bad-loan ratio reflects a better stock of borrowers or merely a larger denominator. Early missed payments by loan vintage are especially useful when new credit has had little time to season. RBI Financial Stability Report, financial institutions chapter

What the next report needs to show

The RBI should track the ability of banks and non-banks to maintain credit to comparable borrowers under stress. Useful measures include unused credit lines, renewal rates, new lending spreads after controlling for risk, the maturity of wholesale funding and the share of capital held by institutions with thin buffers. If isolated losses are absorbed and viable firms can continue to draw and renew facilities, the case for confidence strengthens. If aggregate capital stays high while loan approvals collapse in several exposed segments and wholesale funding becomes more concentrated, the system is transmitting distress even though its solvency indicators remain reassuring. India’s improved bank balance sheets are valuable because they give lenders a chance to keep financing sound activity in a downturn.